The Breakdown - Will Coinbase's Launch of BASE Ignite the Crypto Builders?

Episode Date: August 10, 2023

Coinbase has launched BASE to much fanfare and excitement. The skeptics ask how much it will be about memecoins and speculation vs real utility, but even they're not enough to dampen enthusiasm. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Thursday, August 10th, and today we are talking about Coinbase's attempt to bring the world on chain. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to Bit. breakdown pod. All right, friends, well, as you heard from that introduction, today we are talking about Coinbase's base layer two, day one was yesterday, but before we do that, we need to do a little check-in on CPI. Today was CPI Day, and this is always a good chance to get a gut-level sense

for where the macro is at the moment. And of course, to get a gut-level sense of the macro, or specifically the Fed's part in the macro, there's perhaps no one that markets listen to more than Nick Timoros, the chief economics correspondent at the Wall Street Journal, who is widely seen as having the most direct line to the Fed. A couple days ago, he tweeted, Wall Street forecasters expect the July CPI to show the headline in core indices rose 0.2% each from June. That would lower the 12-month core CPI to 4.7% from 4.8% in June, while boosting the headline index to 3.3% from 3.0% in June. Now, given that the markets really started to consolidate around this prediction,

a lot of the discussion was not so much about what the numbers would be, but what the anticipated slight increase in inflation would represent from a narrative interpretation standpoint. The Kobayisi letter wrote, The fight against inflation is about to get really interesting. Inflation is set to begin rising again just as a Fed pause is expected. This is why the Fed is leaving all possibilities on the table. The fight against inflation continues. While the Fed's work seems to be near its end, the next few months will be interesting.

It's never as simple as just raise rates and lower them later. Apollo Macro tweeted, if CPI comes in soft this morning, lots of bros think the curve flattens and rates fall. They are all backwards. The second great inflation wave is already underway, and the Fed pause on falling core is going to detonate the long end. Another big dimension of the story is the China deflation showing up as we had discussed yesterday. Finance Alot tweeted, counterintuitive opinion, if CPI comes in slightly hot tomorrow, they'll use that as a bullish narrative to quote unquote prove the U.S. economy is resilient in the face of Chinese deflation. What the talking heads won't tell the public is, unlike previous

recessions, this one starts in China. Now, whether finance a lot is wrong or right, one thing that is interesting to note is that we haven't really had a recession for a very long time that wasn't started by a financial crisis. Instead, right now, it appears if we got one, it would be led by a manufacturing drop-off. We're just not used to that anymore, and so we don't necessarily know how to interpret it. In any case, there is definitely a sense of impending volatility coming down the line. Macro-commentator Fajow wrote, Why I think Resolution is now on the horizon as the summer begins to reach an end. CPI bottomed last month and the base effects are about to get worse for the next,

while making it harder to beat moving forward. Energy is bouncing here and will make headline CPI harder to overcome. The Bank of Japan is trying to unwind yield curve control now, which is complicated but could basically lead to dollar strength and higher yields, both negative for risk assets. Yellen and the Treasury announced last week that they want to issue way more bonds than what they originally planned, and a lot of that will be on the long end, which will lead to higher yields and less demand steps up for the long end bid. But that would only come if recession finally shows up, which isn't bullish for risk anyway. Positioning is extended and even the biggest bears are throwing in the towel and calling for no recession and

becoming bullish. Metas have become exhausted. The AI bid is slowing. Finally, typically big trend shifts occur in September when Tradfai returns from summer vacation and begin to rebalance portfolios and reallocate. This leads to an increase in volatility. So obviously there is a lot going on here, but one thing we have to ask is what is the Fed signaling that it wants to do? Well, last week, New York Fed President John Williams spoke with the New York Times. When asked if he believed additional rate hikes will be needed to address inflation, he said, we definitely have a restrictive stance of monetary policy. Real interest rates are well above what I think neutral is. From my perspective, monetary policy is in a good place.

We've got the policy where we need to be, but whether we need to adjust it in terms of that peak rate, but also how long we need to keep a restrictive stance is going to depend on the data. As Nick Timmeros put it, those comments don't sound like someone who's very eager to raise rates again. Now, when all was said and done, CPI came in, as Bloomberg summed up, quote, largely exactly what economists expected. So, as everyone speculates, really the next thing to watch is where the narrative leads markets next. But with that, let's shift over to our main topic today, and that is base. Now, why I think this is interesting to explore is that the beginning of bull markets tend to have a convergence of different factors. One is, of course, narrative, and the second is around

what in franchise builders are doing. Let's take the example of early 2020. You'll remember that DFI Summer happened right after the Paul Tudor Jones' great monetary inflation thesis. So you had, on the one hand, Bitcoin and Institution supplying a narrative, while on the other hand in franchise builders were getting dirty in the sandbox of DFI. Right now, we once again have Bitcoin and institution supplying a narrative. And so the question becomes, is base, an example of where and franchise builders are doing things. But let's take a step back. Base is, of course, Coinbase's blockchain. It's an Ethereum layer two built using the Optimism Tech Stack, and it went live yesterday. Base can host all the usual defy apps and NFT functionality of the Ethereum

ecosystem with much lower fees than just working on Ethereum itself. As a layer two, transaction execution and computation is handled on the base blockchain, allowing for a faster on-chain experience. Settlement then occurs on the Ethereum main net, allowing base to piggyback on the security of Ethereum. Now, base is the culmination of long-term plans laid out by Coinbase CEO Brian Armstrong way back in 2016. In a blog post back then, Armstrong identified four phases of adoption he saw for the crypto industry and how Coinbase planned to participate in each one. The first three phases were early protocol formation, building exchanges in secure custody, then building consumer-friendly wallets. The final phase, which Armstrong identified as Finance

2.0, involved the building and scaling of decentralized apps which would allow blockchains to facilitate more complex financial services. Now, on the one hand, base obviously isn't the start of on-chain financial services. We just talked about how Defy Summer kicked off the last bull market. However, by bringing Defi to users in a more consumer-friendly package, many believe that Base could play a meaningful role in scaling Defi to the 1 billion users Armstrong envisioned way back in 2016. Now, Base had allowed early access to developers over the past few weeks for the purposes of testing, and during that time, some traders figured out how to get access to the pre-long blockchain, bridging funds across and leading to the notorious bald meme coin rugpole a couple

weeks ago. Due to that early speculative liquidity, base is already the fifth largest Ethereum layer two in terms of total value locked, with 139 million in deposits locked into apps and protocols across the ecosystem. Also, according to Coinbase, there are 100 apps either deployed or ready to go on the newly launched network. So one big question is whether this is going to lead to more speculation or more utility or both. A big critique, of course, of DeFi after several years of building, is that its main use is still to facilitate speculation. Now, candidly, for those who choose to take that critique, the same is true for crypto assets more broadly.

However, Jesse Pollock, who oversees the base project at Coinbase, said that his ambition is to help move the crypto industry out of the era of fever of speculation and into something fundamentally more grounded. He said, historically, the aperture of what people can do with crypto has been relatively limited, mostly speculation. In order for Coinbase and crypto and this work that we're doing

to have the impact that we all want, we need to move from the place where this is speculation, to a place where this is integrated into every part of someone's day-to-day existence. Now, interestingly, some pushed back on the notion that speculation and utility were at odds, or that speculation was somehow bad. Paradigm co-founder Matt Huang said, Speculation is the hello world of digital property rights, enable people to create scarce digital things and they will trade them around.

It's naive to think that speculation won't happen, but unimaginative to think that's all there is. Now, speaking of speculation, according to Nansen data, there is a cohort of 22 early whales on base, who each bridged over 100-eath prior to the official launch. This group appeared to be massively overweight meme coins going into launch day. Nansen analyst Niklaus Polk said, there is a heavy meme coin bias in the selection of these whales. There was not much else to do on base except aping meme coins, hence most of the whales in the report have some affinity to this.

Now, frankly, obviously early meme coin speculation is to be expected for this or any new protocol. The real question, the real proof in the pudding will be whether base can successfully transition from just that meme coin trading venue into something that is more driven by utility. Many are pretty optimistic. Indeed, another Nansen research analyst Jake Kennes said with more apps coming online, we'll likely see a more mature ecosystem not solely revolved around meme coins. And this is important. Crypto investor Fisconti tweeted a couple days ago,

Most important step for defy is being closer to the end user in real commerce than it is to crypto-Twitter yield farm speculation. This is the final boss for Defy, not figuring out how to make LPs 10% more efficient and how to aggregate LSDs to make the yield 1.5% higher. Now, another strategy BASE seems to be employing for mainstream appeal is pulling in brands. As part of the launch, Coinbase has announced a multi-week event they're calling OnChane Summer. The event features art, gaming and music, all delivered via daily free NFTments. The company reports over 50 brands and Dow's are collaborating with BASE to bring the fun on-chain. According to EtherScan data, over 125,000 users have minted 30 million NFTs so far. The headline partnerships with real-world

brands are Coca-Cola and Atari, while NFT celebrity Cosimo de Medici, Nouns Dow, Friends with Benefits and OpenC are representing the world of Web3 brands. Now we haven't seen yet what companies like Coke have in mind, but alongside the brand participation, Coinbase is also hosting a quest system to help new users learn how to operate on chain. Jesse Pollock again said, we want to give people a reason to be on chain this summer and set up their first wallet and experience this future. Now the days of brands figuring out exactly how to use Web3 are still frankly very early. One really notable example, while many point to things like Starbucks using NFTs in blockchain to reimagine their customer rewards program, one really interesting

story to me at least comes from Reddit. Reddit launched Avatar NFTs and to begin with, most users didn't even know they were interacting with a blockchain. Instead, they were simply making in-app purchases of custom avatars. Later on, these avatar NFTs became a hit on open NFT marketplaces, and some accidental early adopters found out their avatar had value on the resale market. Now, it seems small, but in some ways it's an example of why the language around blockchain can be as distracting as it is helpful when it comes to bringing new people into this digital space. Now, perhaps the most striking thing about the base launch is that this is the first time that a publicly traded company has launched a public blockchain. Investor and Empire Popper, and, Empire

podcast co-host Santiago Santos said, let's take a moment to appreciate the novelty of a centralized public company launching decentralized public infrastructure. Coinbase is a mission-driven company and will likely go down as the most impactful company to push crypto mainstream. Now, Jesse Pollock again gave some insight into just what it's taken in terms of compliance to get to this point. In a recent interview, he said, launching a decentralized open permissionless blockchain out of a public centralized company, no one's done that before. There's no playbook.

And we've applied all of the Coinbase rigor to doing this over the last. year, which includes working with literally every single part of the company, from legal to compliance, to finance, to privacy, to regulatory, to ensure that we're doing it to the Coinbase values, which is to be deliberate, to be thoughtful, to be measured, to be secure, to be trusted. And so at every turn, we have really gone above and beyond to make sure that we're doing this in the right way. Now, Pollock was also open about the fact that regulations around operating a public blockchain are not all that clear.

Most of the lawsuits around crypto have, of course, been in relation to tokens rather than blockchain infrastructure. Coinbase appears to attempt to avoid additional lawsuits by using ETH as their native token for base, and having zero involvement in any of the fungible token issuance happening on chain. Now, the interesting tension is that while Coinbase is operating most of the core underlying infrastructure, the sequencer, the wallets, etc., they're outsourcing all of the apps and asset issuance to third parties. This means none of the trading venues, lending protocols, or meme coins are controlled by Coinbase. They're just handling the blockchain functionality.

At this stage, we just don't know whether regulators will consider Coinbase's having responsibility and therefore liability for the things that happen on base. One interpretation is that this is Coinbase planting a flag in the unclear regulatory ground, essentially saying to regulators, look, we believe we're legally allowed to launch this product, so we're going to. If anything we've seen recently from Coinbase, it's that it's comfortable availing itself of the courts to make its point and fight its battles. Now, there is going to be a lot more to discuss with base as more usage kicks up as we find out what people are doing with it. And I think one thing to be aware of is that it seems unlikely that just for it existing, there's some crazy big new use case right away. What seems more

possible is that it becomes a galvanizing force for that early bull market enthusiasm and might accelerate whatever innovations or interesting new experiments were going to happen anyway because of how much energy and attention is now being concentrated in a single area. Like I said, to the extent the pattern from 2020 holds up, we really are seeing a very similar combination of emergent Bitcoin institutional narrative, and potentially with base, a new sandbox for enfranchised builders. Will we ultimately see that as the starting gun for the next bull run? Hard to say for now, but it's hard not to be excited about enthusiasm and optimism for once instead of just another lawsuit.

Congrats to the team at Coinbase for the launch. Good luck to the builders out there experimenting, and until next time, be safe and take care of each other. Peace.